A China Turnaround? 5 Key Issues Still at Play

by Jeff Reeves | September 18, 2012 9:38 am

China is in dire straits, with many investments in the region taking a bath in the last year or two. But there are signs of life in certain areas.

Consider that China oil major CNOOC Limited (NYSE:CEO[1]) is up 18% so far in 2012, double other oil majors like Exxon Mobil (NYSE:XOM[2]), and recently made a huge $15 billion bid for natural gas company[3] Nexen (NYSE:NXY[4]).

Then take this line from Daisuke Nomoto[5], portfolio manager of Columbia Pacific/Asia Fund (MUTF:CASAX[6]): “The worst is over for China,” Nomoto says. “In the third quarter of this year, we should begin to see the positive impact of all the monetary and fiscal policies.”

So is China still crashing, or is China turning around?

Unfortunately, there still are some major concerns worldwide to work out — the least of which are recession in Europe hurting demand and the prospect of continued consumer pain in America. Here are a few key points that prove China still is very much a risky bet right now:

Chinese Shipping Trends

A rather obscure trade site, Lloyd’s Loading List, reported on Monday that the Shanghai Containerised Freight Index has fallen by more than 5% in the past week. That’s especially troublesome considering that now is theoretically the peak shipping time for the Western holidays. Demand tends to be high in September and October to stock retailers for November and December.

But “volumes have fallen on the trades into Europe and rather than the usual seasonal surge in cargo, lines have been forced to reduce capacity by blanking sailings or suspending services.”

That’s troubling. Even more troubling is this chart from FT.com blog Beyondbrics:

True, there’s more traffic from China than just the Shanghai-to-Rotterdam route … and even after recent falls, shipping rates still are higher than they were a year ago. But the trend is worth noting.

Further reading also comes from MarineLink.com[7], where execs from major shipper Maersk are quoted as saying that China’s slowing trade indicates the nation “may have lost some of its competitiveness in some areas of the manufacturing sector.” Furthermore, Maersk officials say China’s shift from labor-intensive to capital-intensive manufacturing is a natural given the growth phase the nation is now in — but that exports of more sophisticated products are unlikely to offset the dip in volume in the short-term.

The bottom line is that if shipping and exports look anemic, China can’t be doing well.

China Housing Still Ugly

There has been talk of a China property bubble for many months now — I beat that drum myself, in fact, way back in February[8]. And during the past 11 years, the investment in residential housing as a percentage of China’s GDP has tripled. Sound like another housing-led bubble that American investors might know intimately?

It doesn’t help that China’s economic stimulus efforts have effectively increased the country’s money supply — but policies and culture leave that money trapped, with nowhere to go domestically but real estate. Hence the crazy stories of ghost cities[9] full of empty commercial real estate and condo complexes. Where else can you put your cash if you’re in China, especially with equities underperforming so dramatically?

The result was a bubble. And here’s a chart from the WSJ showing the steep drop in home prices that has only recently started to bottom.

Some think housing might be ready to turn around. But remember, we did not see a V-shaped recovery after our housing crisis in America, and it’s unrealistic to think a snap-back will happen in China.

Furthermore, there is more bad news lately: Premier Wen Jaibao placed controls on housing prices[10] after the crash to prevent another overheating. And while things are less bad, they certainly aren’t good. Consider that compared with 2011 numbers, prices of newly built homes fell in 53 of the 70 cities in August vs. 58 cities with a downturn in July.

That’s “better,” per se, but 76% of cities seeing falling prices still is not a good thing.

Commodities: A Canary in the Coal Mine

I do not buy into the doomsday scenario outlined by some that commodity prices will be gutted in the next few years by the China slowdown. But it’s impossible to ignore how commodity prices have dropped substantially from peaks a year or two ago.

Consider the collapse in coal stocks[11], or the rollback in base metal prices like copper and aluminum since peaking in summer of 2011. Even oil hasn’t been able to break through $100 for long in the last year or two. Global markets are complicated, but China is the world’s biggest manufacturing market, and its hunger for energy is unmatched.

The softness in commodity prices says a lot about softness in China.

Commodity traders know this. China expert Michael Pettis posted a recent article on his blog China Financial Markets predicting a further collapse in commodities through 2015[12]. In it, he writes that “almost all the increase in demand in the past twenty years, which in practice occurred mostly in the past decade, can be explained as the consequence of the incredibly unbalanced growth process in China.”

In short, he’s bearish on commodities in large part because China is slowing down — but also because its economic makeup is changing.

China Stocks Still Slumping

This one is obvious. The iShares FTSE/Xinhua China 25 Index ETF (NYSE:FXI[13]), a clear proxy for China large caps, is down 5% in the past 12 months vs. a 20% rally for the S&P 500. Among those big names in the red include Internet search giant Baidu (NASDAQ:BIDU[14]), down 23% in the last year, and major telecom China Unicom (NYSE:CHU[15]), down 22%.

And as I outlined in a recap of the best global markets of the last year or two[16] (surprise, America is No. 1!), China has significantly underperformed when you compare the Shanghai composite with other major exchanges around the world — including London and Tokyo.

The crash has already happened in Chinese equities. So the only question is whether the pain in the aforementioned areas will continue, or if there’s a turnaround in the near future.

Considering that most China stocks remain pointing downward, it appears investors haven’t seen enough to get bullish on the region just yet. You might argue that means you can get in now and be first … but just remember the risk of doing that, especially while U.S. equity markets are soaring in 2012.

Warning Signs Are Prohibited. Move Along.

I’m gonna steal this from Josh Brown at TheReformedBroker.com[17] because it’s too good and too spot-on to bother recasting (emphasis his):

“China is a very different animal, a lie wrapped in a deception cloaked in a propaganda program dragged by an idle cement mixer. There is no roadmap, there is no precedence and there are no rules. (Each) ongoing datapoint has the government’s fingerprints all over it before we get to see it. Economic targets issued by Beijing are treated as though they are actually orders by the millions of government officials in charge carrying them out.”

In short, who the hell knows what’s really going on in China?

Given that, it’s awfully hard to start looking for signs of a bottom because Beijing will always spin the news and the numbers to put the best face on a bad situation.

Bottom line: Don’t buy a bottom in China yet.

Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.”[18] Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.